Completed 13 Apr 2018 04:05 AM HKT Disseminated 13 Apr 2018 04:06 AM HKT Economic Research April 2018 Is inflation dead? A discussion Sajjid Chinoy sajjid.z.chinoy@jpmorgan.com (91-22) 6157-3386 JPMorgan Chase Bank, N.A., Mumbai Branch See the end pages of this presentation for important disclosures. 1
Arthur Lewis meets Gary Becker A thought-provoking, and ingenious approach to explaining the inflation slowdown Highlights a very different, and heretofore underappreciated, dimension of globalization (injection of high-skill labor, versus the conventional wisdom of low-skill labor, technology, capital) Two potentially-interrelated, but analytically separable, questions The role of USSL in the great inflation decline (GID) vis-àvis slack/expectations/oil prices Outlook for inflation: is inflation dead? 2
Core inflation: A tale of two halves? Core Inflation (Headline adjusted for food and fuel) % year-on-year 6.0 5.0 4.0 3.0 2.0 1.0 0.0 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Source: J.P. Morgan calculations 3
Headline and core reveal different dynamics Source: Is Inflation Dead, by Surjit Bhalla. 4
Different decades, different dynamics 1990s % 6.0 2000s %, 12QMA 2.5 Global 5.0 2.0 4.0 1.5 3.0 Global 1.0 Advanced 2.0 1.0 Advanced Economies 0.5 0.0 91 93 95 97 99 0.0 00 02 04 06 08 10 12 14 16 Advanced economy core inflation consistently below 2% but has not secularly fallen over since 2000 Source: J.P. Morgan calculations 5
Why did inflation fall in the1990s? The great moderation Real Policy Rates, Advanced Economies %pa; Policy rate less core inflation Inflation expectations (median) % 10 8 6 8 4 6 2 5-10Y Ahead 0 4 1Y Ahead -2-4 71 76 81 86 91 96 01 06 11 16 2 78 82 86 90 94 98 02 06 10 14 Source: J.P. Morgan; Recession bars are for DM Source: University of Michigan Source: J.P. Morgan calculations, University of Michigan Surveys 6
meets the positive supply shock from globalization Global trade* % of GDP 60 China goods exports % of GDP 40 Exports 50 40 30 30 20 10 Net 20 1966 1976 1986 1996 2006 2016 *imports + exports goods and services Source: World Bank US Potential growth % 5 4 3 2 1 0 80 90 00 10 Source: CBO 0 70 80 90 00 10 Source: NBS, GAS Global GDP Growth and Core Inflation % oya, 3YMA 4.5 3.6 2.7 1.8 0.9 0.0 93 94 95 96 97 98 99 00 Source: IMF, JPM research 7 Core inflation GDP growth
Discriminating among hypotheses Undisputed slowdown of headline and core in the 1990s Indicative of a positive supply shock But many potential factors that may have underpinned it: Injection of capital and low-skilled labor from globalization Disinflation forces from technologically-induced productivity boom in the U.S. Anchored inflation expectations USSL embodied disproportionately in goods or services? 8
But no secular decline in core inflation since then Core Inflation % 4.0 Commodity prices (CRY Index) Index 500 3.5 3.0 2.5 2.0 1.5 Emerging Economies Global 450 400 350 300 250 200 150 1.0 Advanced Economies 0.5 0.0 02 04 06 08 10 12 14 16 Source: J.P. Morgan calculations, Bloomberg 9 100 50 0 94 96 98 00 02 04 06 08 10 12 14 16 18 Source:
Modest declines post-gfc accompanied by meaningful growth slowdowns Advanced Economies %, oya 3 Emerging Economies %, oya 7 6.5 2.5 2 2.4 1.9 Pre-GFC Post-GFC 6 5 5.3 Pre-GFC Post-GFC 1.5 1.5 1.3 4 3 3.4 3.1 1 2 0.5 1 0 Growth Core Inflation 0 Growth Core Inflation Source: J.P. Morgan calculations 10
Philips Curve: Rumors of my death are grossly exaggerated % % oya 4.0 3.3 4.5 3.1 DM: Wages 5.0 2.9 % oya % of potential 2.0 1.90 DM: Core Inflation 1.0 1.70 0.0 5.5 6.0 6.5 7.0 DM: Unemployment 2.7 2.5 2.3 2.1 1.50 1.30 1.10-1.0-2.0-3.0 7.5 1.9 0.90-4.0 8.0 8.5 1.7 1.5 0.70 DM: Output Gap -5.0 9.0 01 03 05 07 09 11 13 15 17 1.3 0.50 01 03 05 07 09 11 13 15 17-6.0 Source: J.P. Morgan calculations 11
WEO finds slack player a key role in inflation misses Source: World Economic Outlook, IMF 12
With both inflation expectations and slack playing a role Source: World Economic Outlook, IMF 13
Where should USSL show up? Goods or services? Service inflation much stickier US Consumer Price Inflation: Services much more sticky % oya 7 6 5 Core services 4 3 2 1 0-1 -2-3 Core goods 00 05 10 15 Source: BLS 14
Wage growth has slowed in AEs since the GFC Real Wages, DM % oya, 4qmq 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 01 03 05 07 09 11 13 15 17 Source: World Economic Outlook, IMF, J.P. Morgan calculations 15
But so has productivity growth Productivity Growth, DM % oya, 4qma 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5-2.0 01 03 05 07 09 11 13 15 17 Global labor productivity %oya (dashed show 2002-06 avg) 5 Emerging * 4 3 2 1 Developed 0-1 -2 02 05 08 11 14 17 Source: J.P. Morgan; * Productvity is GDP/Employment (excludes China, India) Source: J.P. Morgan calculations 16
Pushing up unit labor costs Underlying compensation per hour and ULC %oya 8 6 4 2 0-2 97 02 07 12 17 Source: J.P. Morgan Underlying comp per hour Source: J.P. Morgan calculations, BLS Underlying unit labor costs US: Core inflation % oya 3.0 2.5 2.0 1.5 1.0 0.5 0.0 08 Source: BLS 10 12 14 16 18 US: Core inflation momentum % 3m/3m, saar 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Source: BLS 17 07 08 09 10 11 12 13 14 15 16 17
The wages conundrum US domestic corporate profit margin % of corporate value added (1Q17 excludes settlements) 18 16 14 12 10 8 70 75 80 85 90 95 00 05 10 15 Source: BEA, FRB Slowdown in wages can be partially explained by slowdown in productivity But corporate profits unusually high for this stage of business cycle Wage slowdown greater than productivity? Abnormally low cost of capital? USSL can be an explanation here But (1) wage slowdown only after GFC; (2) shouldn t USSL push labor productivity up? 18
Rephrasing the problem DM policy, u-rates and core CPI %, both scales 4 Policy rate U-rate (inverted) 4.5 5.0 5.5 3 6.0 Core CPI (oya) 6.5 2 7.0 7.5 1 8.0 8.5 0 96 01 06 11 16 Source: J.P. Morgan 9.0 19
Putting it all together Core inflation slowed sharply in the 1990s but remained sticky after that Core inflation not immune to output gaps and slack, even though Phillips curve may have flattened No secular decline in wage growth or unit labor costs over three decades, as USSL would imply? Wage growth has slowed, but since GFC, and partly explained by lower labor productivity Implications As protectionism rises and USSL is interrupted, does inflation climb back up? As slack continues to reduce, does inflation go back up, despite a flatter Phillips Curve? 20
Suggestions Use core rather than headline inflation Use an Augmented Phillips Curve approach controlling for inflations expectations and slack and testing USSL explanatory power after controlling for traditional variables See if there are structural breaks since experience of 2000s very different from 1990s Why not run wage growth on USSL but after adjusting for labour productivity? Split core inflation into core goods and core services to test for differential impacts? 21
What has driven India s sharp disinflation? India: CPI (IW) % oya 20 Average inflation from 2006-2013: 9% was 9% India: Food inflation % oya 14 Trend-line 10 6 Food inflation 15 10 5 0 Source: 90 Labour Bureau95 00 05 10 15 2-2 13 Source: MOSPI Core-Core inflation % oya 6.0 5.5 5.0 4.5 4.0 3.5 15 16 17 18 Source: MOSPI 22
What has driven India s sharp disinflation? Table 2: Determinants of Inflation in India Dependent variable: Year-on-Year CPI Inflation Rate Output gap - HP filter - 1Q lag 0.52** Annual growth in wages - 1Q lag -0.04 Annual growth in MSP - 1Q lag 0.06^ Dummy for below normal monsoon 0.67* Annual growth in $/Re. exchange rate - 1Q lag -0.08** Annual growth in world food price index - 1Q lag 0.02 Annual growth in world food price index - 2Q lag -0.03^ Annual growth in world food price index - 3Q lag 0.01 Annual growth in world food price index - 4Q lag 0.00 Annual growth in world food price index - 5Q lag 0.01 Annual growth in world food price index - 6Q lag -0.02 Annual growth in world food price index - 7Q lag 0.04* Annual growth in world food price index - 8Q lag 0.00 Annual growth in world crude price - 1Q lag 0.01^ Dummy for new monetary policy regime# -1.43** CPI inflation - 1Q lag 0.41** CPI inflation - 2Q lag 0.23 CPI inflation - 3Q lag 0.18 CPI inflation - 4Q lag -0.30** CPI inflation - 5Q lag 0.47** CPI inflation - 6Q lag 0.01 CPI inflation - 7Q lag 0.01 CPI inflation - 8Q lag -0.21** Observations 60 R-squared 0.96 D-W-statistic 1.96 B-G serial correlation test (LM test) 0.16 AIC 2.50 SBC 3.33 ** indicates significant at 5% level, * indicates significant at 10% level, ^ indicates significant at 15% level. #: NEWREGIME is a binary 1 for 2014Q1-2015Q1, a substantially low yoy inflation period. 23 Source: What is Responsible for India s Sharp Disinflation? by Sajjid Chinoy, Pankaj Kumar and Prachi Mishra, IMF Working Paper
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